A&P convertibles look attractive for both outright, hedged investors: Lehman analysts

By Rebecca Melvin

New York, April 7 - The Great Atlantic & Pacific Tea Co. Inc.'s $420 million of convertibles issued last December are attractive on both an outright and arbitrage basis due to the company's improving credit story, Lehman Brothers convertibles analysts said Monday in a research report.

On a relative value basis, the A&P 6.75% convertibles due 2012 are preferred over the A&P 5.125% convertibles due 2011, the Lehman analysts said.

"But we like them both," a Lehman analyst told Prospect News.

The 6.75% convertibles, known as the B tranche, are longer-dated and are seen 4.77% cheap, compared to the shorter-dated 5.125% paper, known as the A tranche, seen 1.69% cheap.

The 6.75% convertibles have a higher yield to maturity, or yield to put, of 7.5%, compared to the A tranche, which has a yield to maturity or yield to put of 5.3%.

The delta value of the B tranche is 58.3%, compared to 56.8% for the A tranche. There's positive carry for both bonds (one-year carry at 1.81 points for the As and 2.91 points for the Bs) and attractive convexity (gamma 0.68% and 0.60% for the As and the Bs).

While the credit picture for A&P is weaker than its peers, the analysts believe that its credit fundamentals will improve with increased operational performance and realized merger synergies. There is also a sizable equity cushion, they said.

A&P completed its acquisition of Pathmark in December and subsequently issued the two securities.

The combined company operates 450 stores in the New York and Philadelphia areas under the banners of Waldbaum's, the Food Emporium, Super Fresh and Food Basics, in addition to A&P, A&P Super Foodmart and Pathmark.

The Lehman analysts pointed out that the company's concentration in the Northeast - having sold 43 stores in Michigan and New Orleans last year - is favorable for improved operational efficiency. They see "significant room for margin improvement and synergy."

A&P is based in Montvale, N.J.

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